2017-09-10

Time to Short the Yuan?

The decline of the dollar through my redline has led me to lighten my positioning in the dollar. I still think a bottoming process may be underway though, so I am not yet flipping to a dollar bearish position.

The yuan is a more interesting case since the PBoC announced it would remove reserve requirements on future contracts. The PBoC upped reserve requirements to 20 percent in order to slow yuan depreciation.

China’s central bank plans to tighten rules on trading of currency forwards from October, sources with direct knowledge of the matter told Reuters, in a move to curb speculation and volatility after a shock devaluation of the currency last month.

In the past year, the yuan has followed other currencies in moving higher against the U.S. dollar. There has been yuan depreciation against the euro.

Going back to before the yuan's surprise devaluation in August 2015 shows the yuan remains weaker than euro, the Dollar Index basket, and a basket of emerging market currencies.

China's credit bubble expanded over this period and reserves deteriorated into the end of 2016.

China bulls are optimistic about the bump in global growth, rising copper/commodity prices and/or see China as having the ability to defy Nature without consequence.

Speculators are betting against a December rate hike. The market could turn even more bearish on the prospect for rate hikes, but that would require a deterioration in global economic growth, which would be dollar bullish. The market has to stay in a sweet spot where commodities are rising and the Fed holds off on rate hikes to keep the current dollar weakness going.

The latter story leads into my next thought, which I have held as part of my bearish yuan/China correction thesis, that China would run out of political room at the worst moment. On the one hand, China is flexing its muscles with North Korea, expanding into the South China Sea, had the yuan added to the SDR basket, has A-Shares added to the MSCI Emerging Market Index. On the other hand, President Trump wants tariffs on China. On steel exports, he doesn't need anything except Chinese production and export data. He can also use tensions with North Korea or an incident in the South China Sea. There are several ways for President Trump to quickly turn public support against China. Given social mood and economic conditions, it will likely prove to be wildly popular. Economics, security, nationalism and patriotism all coming together.

China is highly leveraged to itself. It created most of the world's credit over the past several years. The credit is mostly backed by Chinese real estate and hard assets, investments in commodities (or if you're uber-bearish, nothing at all). The Chinese government cracked down on the flight of capital overseas, it is now cracking down on alternative exits such as Bitcoin. According to statements from Chinese cryptocurrency exchanges, it sounds as if China will ban transactions involving CNY. Assuming that is the new policy, it appears to be aimed at capital flight.

Bitcoin exploded from $1900 from July 17 to a high of $5000 on some exchanges on September 2.
The yuan has risen sharply in the past month, staring on August 24. North Korea launched missiles on August 26. On August 28, there were reports that Trump wants tariffs on China. The same day U.S. time (morning in Asia), the DPRK fired an intermediate-range missile over Japan. The recent rapid rise in the yuan looks either like the yuan playing catch-up to the euro and other EM currencies or aimed at mollifying President Trump. It looks political, not economic.